Globalisation and the Future World Order

This paper was presented to the Curtin Sarawak Research Institute at Curtin University, Sarawak (Miri campus), 22 March, 2013. (And earlier version was presented to a politics class at Victoria University of Wellington). The Power Points are available on request.

Keywords: Globalisation & Trade

I am going to talk about globalisation. I am not using it as some vague abstract term nor as a term of abuse. I define economic globalisation as the process of closer economic integration of regional and national economies. I shall describe the processes which drive that integration. This research area is known as the economics of geography, and it adds a spatial dimension to economics which has – with a few exceptions – been largely lacking. That is why, for an economist, globalisation has both a regional dimension within a country, and a national dimension between countries.

Defined this way globalisation has a long history and is not a new phenomenon. It began centuries ago, but initially it was a very minor part in the history of the world. However, early in the nineteenth century the process began to accelerate and soon began to dominate the world economy.

So let’s go back before then. If you ask those of European descent what were the two largest manufacturers in 1750, they are likely to say Britain and one other country on the European continent. Both are wrong. A quarter of a millenium ago the biggest manufacturers were China and India. In those days manufacturing largely supplied the local population and the two largest populations in the world were in China and India.

Yet within a hundred years the world’s manufacturing was concentrated in North West Europe and, increasingly, the Atlantic seaboard of North America, and they were supplying the rest of the world. Now it is very easy to say it was a different sort of manufacturing – using industrial processes in increasingly large factories. But it evolved out of a manufacturing sector similar to that in Asia. And we know from today’s experience that Asians can be as good at modern manufacturing as Europeans. So why Europe rather than Asia?

In m view it was almost accidental that industrialisation began in a tiny, not very rich and tumultuous peninsula at the west end of the Asian continent – especially in the British Isles just off it. With hindsight one can draw attention to advantages which Europe had. A few hundred years earlier China had been politically more stable and technologically more advanced than Europe and it had a much larger market too.

If I had to draw attention to any single event that inhibited China it was Chinese Emperor, Xuan De, forbidding the building of ships longer than 30 metres in 1432. The ban’s permanence is probably explained by the priority of the defence of China’s land border but it turned the empire in on itself. Four hundred years later, quite unprepared for an invasion from the sea, Emperor Daoguang told the British envoy that Europeans had nothing of interest to China. He did not know about their guns.

The Europeans, on the other hand, had engaged with the world, in part to get resources they lacked – gold silver, spices – but also from curiosity and proselytising Christianity. Sailing required a constant improvement of technologies which fed back into science and domestic technologies. The flowering of Arab science occurred when they were solving the practical problem of the precise direction of Mecca for prayers. Additionally Europeans had to engage with alien cultures, which impacted on their view of the world and the nature of society. The lesson I derive from this is dont be too inward looking.

But whatever the reasons for the European leadership, what is important for our purposes is that at a certain stage in the development of the world, industry began concentrating in particular locations which were not particularly related to population. There were two drivers.

The first was a fall in the costs of distance. Not just transport costs; they include the costs of handling at each end and perhaps in the middle, the time it takes to ship – in commerce time is money, the ease of accessing information and administrative costs.

To illustrate the time dimension consider a picture of the world as seen from New Zealand. One hundred and fifty years ago the world seemed huge and everywhere seemed a long way away. But over time it shrank. Sailing to Europe once took six months, today it is less than four weeks. You can fly there in just over a day. Cables bring information even quicker. Your internet connection is almost instantaneous, affected more by time zones than by the physical distance.

There are many other cost cutting changes – telegraph and containers were important innovations in each century. A change which transformed New Zealand was refrigeration. Prior to 1882 it was nigh on impossible to ship quality meat and butter across the equator. Refrigerated shipping in that year converted an almost infinite cost to a near zero one, and led to the great pastoral boom based on exporting frozen meat and dairy products which shaped twentieth century New Zealand’s economy, politics and society.

Falling costs of distance meant manufacturing was no longer confined to small-scale supplying the locality. Now it could reap economies of scale, lowering costs and shipping to the rest of the world. The age of the large factories was underway; and it was no longer necessary for them to be near the large populations they were supplying.

You might have expected those large factories to have been scattered throughout the world, but a second distance effect called the economies of agglomeration clustered them in selected locations. When factories and their related servicing businesses huddle together, their overall costs fall. Economists list the reasons for these agglomeration effects as:

1. Mass production (the internal economies that are identical to scale economies at the firm’s level);

2. Availability of specialised input services;

3. Formation of highly specialised labour force and the production of new ideas, both based on the accumulation of human capital and face-to-face communications;

4. The existence of modern infrastructure.

So unless a factory is processing a heavy resource , it may be unwise to start up a green-field site away from other businesses because it misses out on these agglomeration advantages.

Of course urban centres also suffer from the diseconomies of congestion, which extends industrial heartland. Thus Europe’s industrialisation started in Britain and crept out to northern and western Europe, and also across the Atlantic (for the costs of water transport are much lower than land transport). In turn the North American heartland on the Atlantic coast crept out to the mid-west and then to the Southern and Pacific States. But basically by the end of the nineteenth century industry was clustered in the Atlantic economies.

It is sometimes it is argued – or implied – that only the North Atlantic economies benefited from this process. Not true. I have reservations about using market output as a measure of welfare but, for the record, output per head in Western Europe is about fifteen times higher than it was at the beginning of the nineteenth century, while Africa, the poorest of continents, has experienced a threefold increase. Not only are Africans better off on this measure, but today average African incomes are higher today than Western Europe’s were two hundred years ago.

Nevertheless there has been a a process of circular cumulative causation in which the rich have got richer faster than the poor. High income countries have generally grown faster, and those with lower incomes have grown much slower, although they have not – as a rule – stagnated.

So from the nineteenth century the world had a two-speed economy. The North Atlantic economies (plus a few of their Southern Hemisphere food supplies such as Australia and New Zealand) grew fast in material output terms; the rest grew much more slowly. So there was a fast pack and a slow pack, and not much in between.

Economists began to construct mathematical models which described this bifurcated economic growth. They are too complicated to explain in the time I have, but they made a couple of interesting predictions, both of which have proved broadly correct.

The first was that sometimes a country in the low growth pack would split off, grow very quickly and catch up to the fast pack. The creeping extension of the industrial heartland to avoid the diseconomies of congestion is an example, but far more spectacular has been Japan which was in the slow pack at the beginning of the twentieth century and had joined the fast pack by the 1980s.

Once it caught up with them Japan’s very rapid growth in the middle of the century slowed down to a rate not too dissimilar to that of the other rich countries. Moreover just as the North Atlantic heartlands spread out, so did Japans’, but to Korea, Taiwan and South East Asia. This is comparable to what happened in America, say, as the Mid-West deindustrialised and industry moved to the American south and California. But there it was seen as a national phenomenon; in Japan’s case it crossed international boundaries. Different political issues, but the underlying economics is much the same.

The economists’ model, comforted by the Japanese example showing that splitting off can happen, makes a second prediction. It suggests that as the costs of distance fall, some industry will relocate to where the world’s population is located. And since they are mainly in Asia, the model suggests that ultimately a much higher proportion of the world’s manufacturing will produced there. Which is what we have been seeing over the last quarter of a century.

To give an intuition of how the model works. The divergence in the growth paths means that those in the fast pack – the rich countries – can pay themselves higher wages, protected by the costs of distance. But as the cost falls, the poor country workers can undercut the rich country workers, and so some of the jobs and the manufacturing moves offshore – say from America to China. Once some businesses get to the new location agglomeration economies start cutting in, and so the poor countries gets into a positive cycle of cumulative causation and start paying higher wages. The wage gap between the rich and poor economies narrows, as it did for Japan.

Before discussing the future implications of this process, I need to add a few caveats.

The first is that while I have been talking about all manufacturing, not all of it is internationally relocatable. You need shoe and car repairers close to where you live. In the real world we need to be careful about the meaning of terms.

Traditionally economists divided the economy into three sectors. The primary sector were those activities which had to be located near the resources they were based upon – farming, forestry, fishing, mining. The tertiary sector were those activities which had to be located near consumers – services. The secondary sector (we tend to call it ‘manufacturing’) was more footloose, to be located somewhere between the extremes of where the resources were and where the consumers were, depending on transport and other distance costs. This meant governments could influence where manufacturing was located by policies, such as border protection, which is why politically the focus of development policy has tended to be on it.

Cheap telecommunications have untied a whole range of services from being close to the consumer. Who would have expected fifty years ago that call centres and business centres could be outsourced offshore? Who would have imagined an effective bookshop on the other side of the world – for that is what amazon.com is? While the internationally tradeable sector was once confined to manufacturing (and tourism), chunks of today’s service sector have joined it. Now there is a ‘tradeable service’ sector as well as a manufacturing one.

The second caveat is whether the costs of distance continue to fall, as I am about to assume. One cannot be sure of course, but I cant see why costs of electronic distance will rise. On the other hand, I expect transport energy costs – the price of oil – to rise faster than inflation. It is possible that, as in the past, the improvement in fuel efficiency will offset the rising costs, but probably means that the costs of distance for goods may not fall as dramaticly as they have in the past although it seems that the economies of agglomeration are intensifying.

Additionally there are some changes which seem to be altering the geography of nations. Global warming is opening up the northern routes via the Bering Strait to the east coast of North America and Europe. An indication of how revolutionary this could be is that Singapore has joined the nations cooperating in the Arctic Ocean. Historically the straits of Malacca have been one of the great choke points in global training routes. Apparently Singapore thinks that the opening of the Arctic routes may have some effect on that.

Another big geographical change may be enlarging the Panama Canal which means East Asia can send bigger shipments to the Atlantic all year. The canal is another choke point because there is a limit on the size of the ships which fit through it. Panamax ships will become obsolete in the second half of this decade. The New Panamaxs are two and a half time larger than the old ones.

On the whole I am inclined to assume that the forces of positive circular accumulation will continue to accelerate Asian growth for some time to come, although sometimes market processes can overreact. Hence the phenomenon in which some production is moving back from Asia to North America. I dont know how big it is. It may slow down the acceleration but I doubt it will reverse it. One thing which may accelerate Asian economic growth is that it is still largely externally driven. At some stage Asian domestic demand has to become a substantial driver of Asian production.

It is even possible that some manufacturing may become more localised from, say, three dimensional printing. There are already some commercial uses, but it is still very expensive, although costs are likely to come down over time. The potential use seems to be very widespread. It may be that ordinary products can be produced in the shop which sells it. You ask for it, the shop downloads the product specification from somewhere far away and the 3D printer makes it for you, possibly in front of your eyes, presumably while you sip a cup of coffee.

Will it happen in our lifetime? It is well to remember that technological forecasting is hazardous – and usually wrong. That applies for me too. About a decade ago I looked at on-site printing of books. Again the idea was simple. You went to the bookstore, told them what you wanted, and they pressed a button, downloaded the electronic template, and soon you had the book you required. Similar idea to 3D printing but it has not worked. I did not foresee e-books, so what seemed to be a perfectly plausible innovation has been jumped over by an even cheaper one.

So there are caveats to the details of the prediction I am going to make, but its central theme seems to be robust. Economic activity is going to move away from being concentrated in a few locations, to being more closely aligned to where the world’s population is. As the pattern of production in the world moves closer to the pattern of population, output per head is likely to converge.

That means there will be, as the model predicts, a convergence of North Atlantic and East and South Asian per capita output levels. It is even possible that the material standards of living of those living in the rich economies will stagnate (or fall). I am surer that they are unlikely to grow as fast as they have in the past. Thus their share of total world output will fall, as it has been falling in the last three decades.

This is likely to have dramatic implications for the work economy and the world as a whole. Let’s think about the medium term. I am going to do this by looking at the five largest economies in the world as measured by GDP (in the same standard prices). In order they are:

The European Union and the United States which are about the same size

China

India and Japan, which are about the same size.

Incidentally the next large economies – Brazil, Russia and South Africa – is each less than half the size of the smallest of the Big Five and is unlikely to catch up. ASEAN, especially were it to extend to encompass Australia and New Zealand, is potentially a large economy with 6 to 7 percent of world GDP. However its political arrangements will be looser than the even European Union’s so it may have a role in the economic leadership but not political leadership of the world.

Each of the Big Five has its own economic, political and social problems; had we time we could mull them over, and I shall allude to some as I go. However I am going to assume they resolve them, although it will take time. I am mindful of Winston Churchill’s ‘America will do the right thing; after it has tried everything else’. That is broadly true everywhere else too; sometimes getting there can be very damaging. I’ll describe a British example shortly.

In the first two hundred years of globalisation, the world was dominated by a single power – what we call a ‘hegemon’. In the nineteenth century the hegemon was Britain. By the middle of the twentieth century the hegemon was America – it still largely is. In principle the European Union could challenge it, but it is a relatively new state and it is still to sort out its political arrangements. (In the shorter term the Global Financial Crisis has added some difficulties.)

Shakespeare said ‘uneasy lies the head that wears the crown’. The American popular debate is obsessed with which country is challenging its hegemony. At various times the concern has been with the Soviet Union, the European Union and Japan. Currently it is China.

This is misleading, a thinking fixated on the past of a globalised world with a dominant economic power. That a globalised world has always had a hegemon does not mean that there will always be one. Instead, it is likely that we are going to have a multipolar world in which no country dominates. While the US may no longer be the hegemonic player in the world economy, it will not be replaced by another dominant power. No country will be big enough in a multipolar world to lead unilaterally; the others can gang up on it.

We can only dimly the multipolar world of the future. While economists know a lot about how to think systematically about a world in which there is one dominant player, and a bit about a world in which there are two major contestants – for that is what monopoly and oligopoly analysis of economics is about – once there are a number of large players, the analysis has no simple insights. Yet the regime the world is entering is one with a number of large contesting players.

Perhaps we are already there. As much as it tries America cannot impose a solution on the whole world as it could in the past. Hence the deadlock in the Doha trade negotiations; it is also happening over the world regime on carbon emissions; and it is likely to happen as they try to sort out the world financial regime. In each case America is powerful enough to be able to veto others’ wishes but not powerful enough to impose its own. That is increasingly true for the others of the Big Five.

A word about America. It is hard to be losing hegemonic power, especially when global hegemony is central to the national psyche. Adjustment will be difficult. Certainly there are American intellectuals who are aware of the changing role of the US, but they are not much listened to. Sometimes President Obama touches on this reality but the politics of the presidency has given him little room to move.

There is the gloomy possibility that America is becoming ungovernable; the congressional deadlock over the budget may be just the beginning. Perhaps it and the rise of the Tea Party reflect an unthinking, barely understood response to declining US hegemonic power, even though this negative response may accelerate the decline. What prospects are there for the world economy in which one of its largest economies and the issuer of the international currency cannot run a disciplined fiscal stance?

I am very mindful of what happened to Britain as hegemony transferred to America. It found it very hard to adjust to adjust to its diminished role. Long after it became a secondary power its national rhetoric continued to claim it was a leading world power. It maintained a military presence far in excess of what its economy could bear, with the consequence of further weakening its economic role. Eventually, and slowly, it had to withdraw from military activity ‘East of Suez’ as it found it could no longer afford to maintain an effective presence there. That led to political destabilisation in South East Asia, the Middle East and the South Atlantic.

Some argue that the US involvement in Iraq has been similarly ruinous. Yet, what happens when the US scales down its military aspirations to be more in line with its economic size? Who will fill the vacuum; how will it be filled? China cannot simply fill the whole vacuum. While its economic performance has been impressive over the last few decades it faces a number of difficulties. To list them briefly.

First, unique in the developing world, China has an aging population, with population dynamics even more problematic than most rich countries’ How quickly will its aging population become an uncomfortable burden?

China’s second problem is that it has serious environmental challenges (as has India) including water shortages, water pollution, dirty air and carbon emissions which may retard or divert its development path.

Third, China is not what we would normally call a democracy, but its development is creating a middle class which is likely to be increasingly uncomfortable with current political arrangements, even if their demands may not be exactly the same as those of Western middle classes. How with the Chinese politburo respond to them?

The fourth problem China faces is really the world’s. It is such a big economy that its growth is creating feedbacks which stifle it and disrupt the world’s economic arrangements. For instance its gargantuan appetite for oil and raw materials drives up everyone’s prices and makes China less internationally competitive since it is not a very efficient user.

Additionally, and fifthly, the Chinese economic miracle has been driven by an export strategy. Importing countries simply cannot absorb China’s exports if they continue to grow at their past rate. How can China switch to greater domestic consumption? And what happens internally when China gets to the point that Japan did in about 1990, and its growth rate slows down to the world average?

The sixth danger is that financial crashes are an integral part of the capitalist monetary systems; China is probably not immune. We dont know enough about the Chinese banking system to be able to assess just how robust it is, but the sniff test suggests that many of its banks have unsatisfactory balance sheets, that the system is fragile and could crash in the wrong shock.

The final, and seventh danger, to be mentioned here, is that China has a number of unresolved border disputes.

The point is that it is unwise to project the past linearly into the future. That there has long been a world hegemon does not always mean that the globalised world will always have one; that the Chinese economy has impressively expanded for some decades does not mean that the Chinese economy will continue to expand as rapidly as it has; it may even experience a period of financial or political turmoil, or both.

I am not saying that China will fail. In the fullness of time, given its population, it will become an increasingly large component of the world economy and a key contributor to world political stability, even if it is not the hegemon. But, because of the difficulties I have listed it will not get there in a linear fashion. Every one of the rest of the Big Five – Europe, America Japan and India – has its own difficulties. Do not expect a smooth transition to the new world order.

How does a small country fit into a multipolar world? Let me offer two pieces of folk wisdom from your region and mine.

First, many years ago New Zealanders learned from Lee Kuan Yew the saying that ‘when elephants fight, it’s the grass that gets trampled; but when elephants make love, the grass will suffer even more’. A multipolar world is going to be difficult enough for the large players; it will be even harder for the small ones.

Second, we New Zealanders like to quote our Nobel prize-winning Ernest Rutherford, perhaps the finest experimental physicist of the twentieth century, who said that ‘we havnt much money so we have to think’.

That is exactly what the smaller economies have to do – think about their strategies for coping in a multipolar world. No one strategy fits every player. The solution for Malaysia is different from the solution for New Zealand.

But the underlying analytics is the same and it rests on the same factual foundation. Once economic activity occurred where the population was. About two hundred years ago it began concentrating in particular areas – initially the North Atlantic economies. The forces which drove this was the falling costs of distance and the economies of agglomeration moderated by the diseconomies of congestion. The logic is that as they become more powerful the activity expands into other regions – as it did for Japan and as it is doing in much of the rest of Asia.

But because population is dispersed throughout the world there will be no hegemon. Rather a handful of economies will vie for world leadership; none will be powerful enough to able to dominate the remainder nor to operate independently of them. The emergence of this multipolar world is already underway.